functions of economy

1. C H A P T E R 2
ESSENTIALS OF ECONOMICS

2. 2. INTRODUCTION
• Q: Why can’t people have anything they want?
• A: People’s wants exceed people’s resources.
• People believe there are unlimited resources, the
truth is that most of the resources are scarce.
• Scarcity is the lack of enough resources to satisfy all
desired uses of those resources.

3. ECONOMICS
• Economics is the study of how individuals and societies
choose to use the scarce resources.
• It is the study of how to best allocate scare resources
among competing uses.
• In their attempt to decide on the best way to use their
scarce resources, they face another issue – the
opportunity cost.
• The opportunity cost means the most desired goods and
services that are missed in order to obtain something
else.

4. ECONOMICS
• Economics mostly involves analyzing what occurs in
markets.
• A market is a group of buyers and sellers of a
product and the arrangement by which they get
together to trade.
• These resources are the basic elements of
production called factors of productions.

5. FACTORS OF PRODUCTIONS
• The factors of production are the resource inputs:
 Land: Natural resources like water, air, soil, minerals.
 Labor: Human capital available to transform
resources into goods, like skills and workers.
 Capital: used in the production of other goods and
services, like machinery, buildings and factories.
 Entrepreneurship: The skills used in creating
products, services and processes.

6. 3. BASIC ECONOMIC QUESTIONS
• Because of the problem of scarcity, three basic
questions have to be asked:
A. WHAT to produce
B. HOW to produce
C. FOR WHOM to produce

7. A. WHAT TO PRODUCE
• People have to decide WHAT they want most.
• Priorities should be set and less desired goods and
services should be sacrificed.
• The alternative combinations of goods and services
that could be produced in a given time period with
all available resources and technology is called
production possibilities.
• The ultimate economic aim of people in a society is
to produce that optimal mix of output.

8. A. WHAT TO PRODUCE
• However, the resources that people and society
have should not be all dedicated to present
consumption.
• Some of these scarce resources must be allocated
to investment – expenditures on production of new
plants and equipment rather than consumption.
• This will lead to more economic growth, which is an
increase in output.

9. AMOUNT OF OUTPUT
• To describe the actual output of an economy, we have to
calculate the monetary value of the products.
• Gross Domestic Product (GDP) refers to the total value of all
final goods and services produced in a country during a
given time period. It is a summary measure of a nation’s
output.
• Moreover, per capita GDP (average GDP) is the total GDP
divided by total population.
• It is an indicator of how much output each individual would
get if all output were divided equally among the population.

10. CONTENT OF OUTPUT
• Besides the amount of total output, the content of output should be
also studied:
a. Household consumption: consumer goods can be durable goods
(like cars or appliances), nondurable goods (like food or gasoline)
and services (like medical care or education).
b. Business investment: Investment goods include plant, machinery or
equipment.
c. Government services: provide social services or to build highways.
d. Net exports: the difference between imports and exports. Exports
are the goods and services produced locally but sold to foreign
buyers. Imports are the goods and services purchased from foreign
sources and sold locally.

11. B. HOW TO PRODUCE
• The ultimate answer to the HOW to produce
question combines efficiency in the use of the
factors of production with proper protection of the
environment and the society as a whole.

12. C. FOR WHOM TO PRODUCE
• FOR WHOM question focuses on how an economy’s
output is distributed across the members of a
society.
• Is it going to be divided equally among all the
people in the society? Can some people have
bigger parts, while others get only a smaller part?

13. C. FOR WHOM TO PRODUCE
• Countries organize their economies in different ways:
 A centrally planned economy is an economy in which the
government decides how economic resources will be
allocated.
 A market economy is an economy in which most economic
decisions are made by consumers and firms.
 A mixed economy is an economy in which most economic
decisions result from the interaction of buyers and sellers in
markets but in which the government plays a significant role in
the allocation of resources.

14. 4. THE SCOPE OF ECONOMICS:
MACROECONOMICS VS MICROECONOMICS
A. Microeconomics
• Microeconomics is concerned with the details of a big
picture.
• It is the study of the individual behavior in the economy.
• Therefore, the focus is on firms which are the primary
producing units in an economy, and on households
which are the consuming units in an economy.
• Firms are the organizations that convert resources which
are the inputs into products which are the outputs.

15. 4. THE SCOPE OF ECONOMICS:
MACROECONOMICS VS MICROECONOMICS
B. Macroeconomics
• Macroeconomics focuses on the behavior of an
entire economy – the big picture.
• It is the study of the collective economic behavior of
the economy as a whole.
• is the branch of economics that examines the
economic behavior of aggregates – inflation,
income, unemployment, output, economic growth,
and so on – on a national scale

16. 5. DEMAND, SUPPLY AND MARKET
EQUILIBRIUM

17. A. DEMAND
• Households make decisions about what product to demand.
• This decision is affected by several factors, like the price and
the income availability.
• Quantity demanded is the number of units of a product that
a household would buy in a given period.
• Changes in the price of a product, or the buyer income, or
the consumer preference will affect the quantity demanded.
• For example, an increase in the price of apple juice will lead
to a decrease in the quantity of apple juice demanded.

18. A. DEMAND
• A demand schedule shows the quantities of a product that a
household would want to buy at different prices.
• A demand curve is a graph that illustrates how much of a given
product a household would want to buy at different prices.
• The law of demand states that there is a negative relationship
between price and quantity demanded.
• That means when the price rises the quantity demanded
decreases, and when price falls the quantity demanded
increases.

19. A. DEMAND
• The sum of all the quantities of good and services
demanded per period by all the households is called
market demand.

21. B. SUPPLY
• Many factors affect the quantity of products supplied like,
the price of the product, the cost of production and the
prices of related products.
• The quantity supplied is the amount of a particular that firms
would offer at a particular price during a given time period.
• Supply schedule shows how much of a product firms will sell
at different prices.
• While supply curve illustrates by a graph, how much of a
good or service a firm will sell at alternative prices.

22. B. SUPPLY
• The law of supply shows that there is a positive
relationship between the quantity of a supplied product
and its price.
• That means an increase in market price will lead to an
increase in quantity supplied, and a decrease in market
price will lead to a decrease in quantity supplied.
• The sum of all that is supplied each period by all
producers if a single product is called market supply.

24. C. MARKET EQUILIBRIUM
• The action of the market depends on the interaction between suppliers and
demanders. Three different conditions might be encountered:
1. The quantity demanded exceeds the quantity supplied. This is called
excess demand or shortage. In this condition, there is a tendency for price
to rise as buyers compete against each other for the limited supply.
2. The quantity supplied exceeds the quantity demanded at the current
price. This situation is called excess supply or surplus. In this situation the
price tends to fall.
3. The quantity supplied equals the quantity demanded at the current price.
This condition is called equilibrium. At equilibrium there is no tendency for
price to change.

26. 6. MARKET STRUCTURE
Perfect competition: market where numerous small firms
produce an identical product.
 Monopolistic competition: many firms supply the same
product, but each enjoys considerable brand loyalty.
Oligopoly: a small number of large firms supply all or most
of a particular product.
 Monopoly: one firm produces the whole market supply
of a particular product.

27. 6. MARKET STRUCTURE

28. MONOPOLY
• For a monopoly to persist, some factors prevent new firms from
entering, these factors are called barriers to entry:
 Economies of scale, which are reductions in costs that occur
during increases in quantities produced.
 Patent which grants exclusive use of the patented product to
the inventor.
 Government rules that impose restrictions to some industries.
 Ownership of a scarce factor of production, like land, labor,
capital or entrepreneurship.